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The Open Text building in Waterloo, Ontario. (Kevin Van Paassen/Kevin Van Paassen / The Globe and Mail)
The Open Text building in Waterloo, Ontario. (Kevin Van Paassen/Kevin Van Paassen / The Globe and Mail)

M&A

Amid takeover fever, Open Text looks like a bargain Add to ...

Even though it is Canada's largest software company, Open Text Corp. doesn't normally command much attention in the investing world. That changed suddenly this past month when Hewlett-Packard Co. offered a 64 per cent premium for one of the firm's rivals.



HP, the world's largest seller of PCs, has made an all-cash offer for Britain's Autonomy that values the business software player at $11-billion (U.S.).

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Open Text shares have climbed about 20 per cent this year, an increase that would pale in comparison to what would happen if a potential buyer emerged offering a premium similar to what HP has given Autonomy.



Eyal Ofir, an analyst with Canaccord Genuity, says that if the same pricing model that HP used on Autonomy were applied to Open Text, the company's shares would fetch between $127 and $159 (U.S.) each. They closed Thursday at $58.15 on the Nasdaq ($56.86 Canadian on the TSX).



In setting their price targets for shares of the Waterloo, Ont.-based company, however, Mr. Ofir and other analysts are not actually pricing in the possibility of a takeover. Canaccord values the shares at 15 times estimated future 12-month adjusted share profit, giving them a target of $70 (U.S). The stock currently trades “at very reasonable multiples” of 12 times adjusted earnings and about nine times enterprise value divided by EBITDA, according to Mr. Ofir, who rates it a “buy.”



Any one of Open Text's software product partners – SAP , Oracle and Microsoft – could make a case for buying the company, Mr. Ofir says, but that doesn't mean they would offer the same “rich multiples” that HP used for Autonomy. HP felt the need to go in high to discourage rival bidders at a critical time when the tech giant is shifting its strategy away from the consumer segment to businesses, he says.



Open Text is one of the principal suppliers of enterprise content management (ECM) software, second only to IBM . ECM tools help businesses organize, sort and access the vast amount of information in their computers.



Over the past eight years, the number of software firms selling ECM software has shrunk through consolidation, a process that will continue, says Mike Abramsky of RBC Dominion Securities Inc.



Possible bidders for Open Text include SAP, Microsoft and Oracle, as well as Xerox , Toshiba, Hitachi and Fujitsu, he said.



Open Text has been the subject of takeover rumours throughout the industry's consolidation, and the speculation rises as the number of possible dance partners dwindles.



Kris Thompson, an analyst with National Bank Financial, says the fact that Open Text recently topped annual revenue of $1-billion makes the firm a more attractive target. IBM is the most likely buyer, followed by SAP and Oracle, he adds. Mr. Thompson values the shares at 11.5 times estimated adjusted earnings for fiscal 2012 and 9.6 times enterprise value divided by EBITDA, giving them a price target of $78. He rates the stock “outperform.”



National Bank Financial recently added Open Text to its “action list,” and rates the stock as one of the firm's “most compelling” investment ideas. There are only nine other stocks on the list.



Mr. Thompson says the value isn't just in the possibility of a takeover. The stock is trading near its lowest trailing price to earnings ratio over the past decade. In addition, “the enterprise software sector seems to be one of the more insulated areas at this point in this economic cycle,” he wrote in a recent report.



Speculation about a takeover has given Open Text shares a welcome lift after the shares tumbled 11 per cent following quarterly results released Aug. 10 that missed analysts' earnings expectations and disappointed in terms of revenue from software licences.



The results caused Mr. Ofir to reduce his target on Open Text shares the next day by $10, after management said it expected licence revenue to slip as it integrates two recent acquisitions.



On a conference call with analysts Aug. 10, management said the process of consolidating those acquisitions – Texas-based Global 360 and Maryland-based Metastorm Inc. – will be disruptive, cutting into licence revenue for each firm by about 10 per cent in the first year. But Open Text says it expects both businesses to return to normal growth in fiscal 2013.



Blair Abernethy of Stifel Nicolaus & Co. is one of only four analysts out of 19 who doesn't have a buy rating on the stock. He is concerned about Open Text's ability to sell more software licences using its own internal resources rather than acquired products.



Mr. Abernethy also notes that Open Text relies heavily on sales to governments, which are cutting their IT budgets in a weak economy, and faces increasing competitive pressures in a consolidating sector. He believes that the company's portfolio of products holds a “significant portion of declining legacy products.”

__________



CONSOLIDATION



Open Text is one of the last independent players in the enterprise content management software space.



2003:

EMC paid $1.8-billion (U.S.) for Documentum.

2006:

Open Text paid $489-million for Hummingbird Ltd.



Oracle paid $440-million for Stellent.



IBM paid $1.6-billion for FileNet Corp.



2009:



Autonomy paid $775-million for Interwoven.





Source: RBC Dominion Securities Inc.

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